Mundell: Fix Euro-Dollar Exchange Rate--Fat Chance

Nobel prize winning economist Robert Mundell has renewed his call for fixing the euro-dollar exchange rate. Although he has advocated this before, this time he has added it to the Chinese call to increase the role of the SDRs. He argues that by fixing the euro-dollar exchange rate, the new economic zone would represent 45%-48% of the world economy and make the adoption of the SDR easier.

Ironically this is very much like the PBOC's Zhou Xiaochuan's articles calling for a "super sovereign currency", but not in the obvious way of sharing similar objectives. Rather than more meaningful similarity is neither represented a true constituency but merely were giving expression to their own views. The Chinese Ambassador to the US confirmed that Zhou was speaking for himself and was not the official line.

Leave aside the mechanics and details about how to fix and maintain the fix, in who's interest would it be in. Should it be at a level that still allows Germany to export roughly 40% of their GDP ? Should it be at a level that allows the US to adopt its own export oriented strategy to correct global imbalances ?

Not purposely trying to make a virtue out of a necessity, but isn't it a good thing that the euro and dollar exchange rate moves and helps absorb some shocks so that the real economy doesn't have to ? The Great Moderation was not simply an achievement of economic management, but it was also about the a function of transferring the volatility from the real economy to financial variables.

Mundell also over-states the case. He says the dollar and sterling's share of the SDR (44% and 11% respectively) should be cut by 4% and 6% respectively so as to make room for the Chinese yuan. He claims that the yuan is the world's third most important currency. He is confused. The Chinese economy may be the third largest in the world, but that does not mean the yuan is the third most important currency in the world. Remember it is not convertible. Despite its much acclaimed $90 bln in yuan swap lines, its trade is overwhelmingly conducted in dollars. Similarly, though for different reasons, while the Japanese economy is the second largest in the world, but the yen is not the second most important or even the third most important currency in the world.

Lastly, Mundell is advocating fixing something that isn't broken. Of all the things that produced the financial and economic crisis, floating exchange rates does not seem to have played a critical role. Leverage, archaic regulation, originate and distribute models, lending based on expected collateral value rather than the borrower's ability to repay, the gaming of the system for short-term profit opportunities would not be addressed by fixing the euro-dollar exchange rate.

It is true that next year, the SDR will be re-jigged, but it is not clear that China's yuan is ready to join. It is most clear that the euro and the dollar exchange rate will still be floating and the role of the SDR is unlikely to supplant the dollar, no matter what its composition is.
Mundell: Fix Euro-Dollar Exchange Rate--Fat Chance Mundell: Fix Euro-Dollar Exchange Rate--Fat Chance Reviewed by magonomics on September 24, 2009 Rating: 5
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